Important information about Price of a Forward Contract

You enter into a forward contract to buy a 10-year, zero coupon bond that will be issued in one year. The face value of the bond is $1,000, and the 1-year and 11-year spot interest rates are 3 percent per annum and 8 percent per annum, respectively. Both of these interest rates are expressed as effective annual yields.

a. What is the forward price of your contract?

b. Suppose both the 1-year and 11-year spot rates unexpectedly shift downward by 2 percent. What is the price of a forward contract otherwise identical to yours?

Solution Preview

A. What is the forward price of the contract?

We first need to calculate the 10 year interest rate at the end of year 1

1 year spot interest rate= 3%
11 year spot interest rate= 8%

Therefore 10 year spot interest rate at the end of year 1= 8.51% ={(1+8%)^11/(1+3%)}^(1/10)-1
(^ ...

Solution Summary

The solution calculates the price of a forward contract for different spot interest rates.